Business context and reporting period
Transcontinental Realty Investors, Inc. (TCI) filed this unaudited Form 10-Q for the three months ended March 31, 2012. TCI invests in apartments, commercial real estate, land and mortgage loans; it is externally advised and managed, and subsidiaries of American Realty Investors, Inc. (ARL) own approximately 82.7% of TCI’s common stock. At quarter-end, TCI reported 64 income-producing properties: 48 apartment communities with 8,777 units and 16 commercial properties, plus 4,288 acres of land.
Financial performance and position
Amounts below are in millions, except per-share data and where noted.
| Metric | Q1 2012 | Q1 2011 or prior year-end |
|---|---|---|
| Rental and other property revenue | $28.9 | $26.4 |
| Operating income (loss) | $4.0 | $(3.4) |
| Net loss attributable to TCI | $(4.2) | $(12.0) |
| Net loss applicable to common shares | $(4.5); $(0.53) per diluted share | $(12.2); $(1.50) per diluted share |
| Cash from operating activities | $0.4 | $(13.9) |
| Cash from investing activities | $15.0 | $37.8 |
| Cash used in financing activities | $(27.5) | $(28.4) |
| Cash and cash equivalents | $7.8 | $20.0 at Dec. 31, 2011 |
| Total assets | $1,115.1 | $1,160.3 at Dec. 31, 2011 |
| Total equity | $137.9 | $141.3 at Dec. 31, 2011 |
Mortgage and loan interest expense was $16.4 million, up from $12.4 million. Reported debt-related balance sheet lines were $857.2 million in total: notes and interest payable of $800.4 million, plus $20.1 million related to assets held for sale, $34.4 million related to properties subject to sales contracts and $2.4 million of stock-secured notes. Total liabilities were $977.1 million. Variable-rate debt was $178.9 million; management estimated that a 1 percentage-point rate increase would reduce annual net income by $1.8 million, or $0.21 per share.
TCI recorded no impairment provision in Q1 2012, compared with $5.2 million in Q1 2011. Discontinued operations included a $3.6 million property-sale gain and a $2.1 million net contribution after tax. The company reported a $65.3 million deferred tax asset fully offset by a valuation allowance.
Material changes versus the prior comparable period
- Revenue rose $2.5 million, mainly from apartments: $2.2 million from properties in lease-up and $0.5 million from same-property operations. Management reported apartment occupancy averaging above 94%; the existing commercial portfolio was broadly consistent.
- Operating results improved substantially, helped by the absence of the prior-year impairment charge. The common-share loss narrowed to $4.5 million from $12.2 million.
- Interest expense increased $4.0 million. Management attributed much of the apartment increase to prepayment penalties on four refinancings and interest on properties no longer in development and therefore no longer eligible for capitalization.
- Interest income increased to $3.2 million from $0.4 million, primarily because TCI began recognizing interest as earned on certain Unified Housing Foundation surplus-cash notes. Previously, unpaid interest was recognized only when cash was received; the change followed consistent cash receipts.
- Operating cash flow improved by $14.3 million to $0.4 million, while investing cash flow fell to $15.0 million from $37.8 million, reflecting lower development spending and lower property-sale proceeds. Cash declined $12.2 million during the quarter.
Outlook, risks and unusual items
Management expects property operations to generate excess cash in 2012, but explicitly states that it will not be sufficient to meet all obligations as they come due. Its stated plans include selling income-producing assets and land, refinancing or extending real estate debt, and obtaining additional property-secured borrowing. No numerical earnings or revenue guidance is provided.
- TCI disclosed that mortgages on properties sold to related parties but still classified as subject to sales contracts are currently in default, primarily for lack of payment. The company is negotiating with lenders to settle or cure defaults; many of the loans include corporate guarantees. Related-party property sales may not be recognized until sale criteria are met, and some may be transferred back.
- Q1 transactions included the sale of Wildflower Villas for $19.6 million, with the buyer assuming $13.7 million of debt, and four apartment-loan refinancings at stated rates of 3.00%–3.03%. TCI also deferred recognition of certain related-party sales because of continuing involvement or other sale-recognition criteria.
- Related-party exposure is significant, including affiliate notes, payables, property transactions and advisory arrangements. TCI reported $25.9 million payable to affiliates at March 31, 2012. The filing cautions that related-party transactions may not be on arm’s-length terms.
- Other stated risks include tenant demand and occupancy, access to financing, debt maturities and interest rates, property-sale timing, development costs and delays, environmental exposure and broader real estate and economic conditions. Management reported no environmental liability expected to have a material adverse effect and no material change to previously disclosed risk factors.
- Subsequent events included a $6.0 million Clarke Garage sale on April 5, 2012, and an April 30 refinancing of Parc at Metro Center for $11.0 million at 2.95%. Disclosure controls were deemed effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Obtain the maturity schedule, covenant status and lender-by-lender details for debt, especially the disclosed mortgage defaults, guarantees and obligations tied to sales-contract properties.
- Assess whether planned asset sales, refinancings and additional borrowing can cover near-term obligations given $7.8 million of quarter-end cash and management’s statement that operating cash alone is insufficient.
- Review collectability and cash realization of notes receivable and accrued interest, including the large related-party balances and the accounting change for surplus-cash notes.
- Evaluate the recurring earnings and cash contribution of properties in lease-up, the sustainability of apartment occupancy above 94%, and the effect of elevated interest expense and refinancing penalties.
- Reconcile the prior-period diluted EPS: the financial statements report $(1.50), while the MD&A cites $(1.49).